Crunch Time

by | May 31, 2021

The first week of each month is always the most important for economists. The calendar is packed with key releases. For investors, early June matters a great deal. Following strong performance thus far in 2021, markets are all but priced for perfection. Global equity indices are at or flirting with all-time highs. Credit spreads are tight. Commodity prices have surged. Government bond markets are becalmed. Volatility is edging lower. 

The coming few days could change all of that. For markets, it is crunch time.

Skeptics might counter that last Friday’s surprising jump in the Fed’s preferred inflation measure—core personal consumption expenditures—barely registered with markets. Bond yields actually dipped. Wags suggest that investors were already ‘checked out’ for the long US holiday weekend. Some might wonder whether economic data really matter that much.

From our perspective, the more plausible conclusion is that last week’s inflation spike was ignored because market participants were unwilling to reposition ahead of the coming week’s data deluge. The corollary is that market participants are looking at data in their totality, trying to discern broader patterns, knowing that individual measures may be distorted by pandemic and policy impacts. 

This week, that theory will be tested, given the breadth of indicators on hand.

Specifically, the first week of June brings key trade, production, survey, inflation and employment data from all major economic regions. Year-on-year comparisons will be distorted by 2020 pandemic impacts, which means that month-on-month figures will be more closely followed. Equally, the pandemic, its massive policy response and uncertainty about how businesses and consumers will react to economic re-opening means that that large forecast errors are probable. That alone could introduce more volatility as investors try to unscramble underlying trends in growth, inflation and corporate profits.

The sheer volume of data releases ahead also suggests that investors will be looking for consistency in the numbers. Are all countries and geographic regions reflecting similar strong increases in demand and production? How widespread are wage and price increases?

Matters kick off early in the week with industrial production releases from South Korea and Japan, as well as China’s purchasing manager indices and European national inflation data. Later in the week South Korean exports, German unemployment, EU ‘flash’ inflation, the twin US ISM reports, US light vehicle sales and the Fed ‘Beige Book’ crowd the calendar. Matters culminate on Friday with the all-important US employment report.

Quite apart from individual details, investors will be watching closely for the interplay between supply and prices. Bottlenecks in global production, trade and employment have held back output growth and employment thus far in the recovery. They have also spawned more widespread price increases. With markets once again within striking distance of cyclical or all-time highs (equities) or otherwise becalmed (bonds), the data distribution between expanding output and price pressures will be scrutinized for its potential impact on monetary policies worldwide. In the parlance of economists, the key variable is the elasticity of supply amid strong increases in demand. 

Already, central banks in Canada and the UK have edged toward the exit from super expansionary monetary policies. The ECB has declared that such thinking premature, while the Federal Reserve has been adamant that price and wage pressures will prove to be transitory. Arguably, the cracks between central bankers are more visible than those between investors.

What market indicators should astute investors watch? 

To begin, any change in market expectations about monetary policy will be reflected in the ‘belly’ of yield curves, namely in the prices and yields of government securities with maturities ranging from two to five years. Over the course of the past nine months, those yields have barely budged, even as yields on longer-date bonds have risen. That outcome betrays enormous confidence that the Federal Reserve and other major central banks will keep their policies unchanged for the next few years, even tolerating inflation overshooting. If doubts begin to creep in about those commitments, based perhaps on changes in views on supply elasticity and how ‘transitory’ price increases may be, intermediate maturity bonds will be first to move.

Another key variable is the value of the US dollar. Contrary to the received wisdom, the dollar has not strengthened despite clear advantages enjoyed by the US economy in population vaccination and fiscal stimulus. The resiliency of the euro and surge in the Chinese renminbi, alongside soaring raw materials prices, reflect instead expectations that the broader global outlook has brightened. To the extent that the incoming data supports the thesis of accelerating global growth, the dollar will remain on its heels.

The number one risk for investors of all stripes remains an earlier than expected withdrawal of monetary policy support. The Fed has staked its credibility with expressions of supreme confidence that accelerating inflation is temporary. 

For a generation, investors have been taught ‘don’t fight the Fed’. They are taking that adage to heart today. But if they ever come to question their Fed allegiance, their portfolios will get crunched. 

Larry Hatheway: Is co-founder of Jackson Hole Economics, Larry worked at GAM Investments as Group Chief Economist and Global Head of Investment Solutions. Larry was also the lead investment manager for various mandates, funds and an actively managed multi-asset index.

About the Author

Larry Hatheway has over 25 years experience as an economist and multi-asset investment professional. He is co-founder, with Alexander Friedman, of Jackson Hole Economics, LLC, which offers commentary and analysis on the global economy, policy & politics, and their broad implications for capital markets. Prior to co-founding Jackson Hole Economics, LLC Larry worked at GAM Investments from 2015-2019 as Group Chief Economist and Global Head of Investment Solutions, where he was responsible for a team of 50 investment professionals managing over $10bn in assets. While at GAM, Larry authored numerous articles on the world economy, policy-making and multi-asset investment strategy.

Larry was also the lead investment manager for various mandates, funds and an actively managed multi-asset index. Larry also served on the GAM Group Management Board, was Chairman of the GAM London Limited Board and served as member of the GAM Investment Management Limited Board. Larry was also Chairman of the GAM Diversity & Inclusion Committee. During his tenure at GAM, Larry was based in London, UK and Zurich, Switzerland.

From 1992 until 2015 Larry worked at UBS Investment Bank as UBS Chief Economist (2005-2015), Head of Global Asset Allocation (2001-2012), Global Head of Fixed Income and Currency Strategy (1998-2001), Chief Economist, Asia (1995-1998) and Senior International Economist (1992-1995). During his tenure at UBS, Larry was also a standing member of the UBS Wealth Management Investment Committee. While at UBS, Larry worked in Zurich, Switzerland, London, UK (various occasions), Singapore and Stamford, CT.

At both GAM Investments and UBS Investment Bank Larry was widely recognised for his appearances on Bloomberg TV, CNBC, the BBC, CNN and other media outlets. He frequently published articles and opinion pieces for Bloomberg, CNBC, Project Syndicate, and The Financial Times, among others.

Before joining UBS in 1992, Larry held roles at the Federal Reserve (Board of Governors), Citibank and Manufacturers Hanover Trust. Larry Hatheway holds a PhD in Economics from the University of Texas, an MA in International Studies from the Johns Hopkins University, and a BA in History and German from Whitman College. Larry is married with four grown children and a loving Cairn Terrier, and resides in Wilson, WY.

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